06/22/2008

Although I worry more than Becker does about the environmental consequences of the production and consumption of oil, and although I want oil prices to remain high--indeed to continue rising--I largely agree with his analysis of the rival proposals for dealing with the present "crisis": allowing more drilling for oil on the outer continental shelf and in Alaska versus imposing an excess profits tax on the oil companies. I agree with him that the former is a good idea and the latter a bad one. But I will qualify my agreement by suggesting policy adjustments to minimize the adverse effects of allowing more drilling or of imposing an excess profits tax.
Expanded drilling in U.S. territory (including our territorial waters) will reduce both U.S. dependence on foreign oil and the wealth of foreign oil-producing countries, many of which are hostile or potentially hostile to the United States. These are important benefits. But there are also significant costs. Any increase in the production of oil from the seabed and from the fragile Alaskan tundra will create environmental damage, both directly, because of the environmental damage caused by the drilling itself (such as, in the case of offshore drilling, the dumping into the ocean of "drill cuttings"‚Äîthe solids that are brought to the surface in drilling an oil well), and indirectly, as a consequence of increased production of oil, because of oil spills by tankers, traffic congestion and highway wear and tear, and, most ominously, increased carbon emissions from the burning of oil as a fuel. Becker notes correctly that the less oil we produce, the more that foreign nations will produce. But given the high price of oil, increasing out oil production will increase total world production rather than just substitute for foreign production. So there will be more tanker spills and more carbon emissions if offshore and Alaska drilling is allowed, since the supply of oil will be greater.
The problems created by an increased supply of oil can be minimized by an increase in the federal gasoline tax (better still would be imposing a tax on carbon emissions, since such a tax would create an incentive to reduce the amount of emissions per unit of gasoline consumed) calibrated to prevent gasoline prices from declining as a consequence of increased production of oil and hence increased supply. Already the shock of $4 a gallon gasoline has caused a modest decline in U.S. consumption of oil, yet $4 is little more than half the retail price of a gallon of gasoline in most European countries. Distances are shorter in Europe, and so U.S. gasoline prices would not have to double in order to make substantial inroads into our oil consumption. But they should not be allowed to fall as a result of increased world supply due to offshore and Alaska drilling.
A gasoline or carbon-emissions tax must not be confused with a tax on the profits of oil companies, which, because of the uncertainties involved in exploring for oil, will, as Becker points out, reduce the incentive to find and exploit new domestic oil fields. (In contrast, a heavy tax on gasoline will increase the incentive to find energy substitutes for oil.) In addition, imposing excess profits taxes sends a bad signal to the business community: that success will be penalized. And there is a danger that the proceeds of the tax would be used to subsidize the purchase of gasoline in order to reduce gasoline prices. The demand would rise without stimulating domestic production, so we would have the worst of all possible worlds: high consumption of oil and increased dependence on foreign production. But in the unhappy event that an excess profits tax is imposed, at least it should be limited to profits from existing oil fields, to minimize the dampening effect on the incentive to develop new fields.
Because the environmental risks of offshore and Alaska drilling are greater than those of drilling for oil on land in the lower 48 states, an environmental excise tax should be placed on the oil produced from offshore and Alaska wells. It is not enough to rely on the tort system to provide sanctions for oil spills. Many of the environmental effects of drilling for oil are individually too small to invite tort suits, yet the cumulative effects can be very large. That is true with respect to effects on fisheries and on the frequency of tanker spills. The more oil that is transported by sea, the more spills there will be, but it will rarely if ever be possible to ascribe a particular spill to a particular producer of the oil that was spilled. An environmental tax is therefore necessary to induce the oil companies to internalize the environmental costs that their activities impose.

Comments

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A gasoline or carbon-emissions tax must not be confused with a tax on the profits of oil companies, which, because of the uncertainties involved in exploring for oil, will, as Becker points out, reduce the incentive to find and exploit new domestic oil fields.

Why wouldn't an oil company's' costs associated with a windfall profits tax be pushed on to the public?

Becker points out that a windfall tax will reduce incentives for exploring oil. But a carbon-emissions or gasoline tax would also cause a decrease in demand - leading to a decrease in exploration as well.

Prof. Mankiw on his blog has written at length about the virtues of a Pigovian tax for oil. Alan Greenspan in his most recent book also reluctantly endorsed the idea. Indeed, Judge Posner recently extolled the virtues of the higher price of oil on this blog. Assuming the "windfall" tax is enforced based on sales of oil/gas in the U.S, doesn't the tax operate much like any pigovian tax?

Our unfortunate political atmosphere makes the notion of raising taxes on gasoline impossible. Isn't the windfall profits tax a politically feasible way of 1) decreasing emissions; and 2) increasing research incentives in other energy resources, and 3) reducing our reliance on oil in the long-term?

Excellent post, but I think B&P overstate the impact of an excess profits tax on the investment behavior of US oil cos. Oil prices and therefore oil co revenue is set on world markets; US firms can R&D all they want but most production is coming from the nationals (oil execs stress this). So an excess profits tax amounts to a tax on good luck--which probably won't significantly skew change R&D behavior.

That said, I hold XOM stock, so I'm not in favor of an excess profit tax-nor should we expect the political process to make decisions based on rational cost-benefit analysis.

These Becker-Posner and Posner-Becker exchanges include a very uncommon amount of quality thinking. We fortunate readers sometimes forget how lucky we are.

That said, I think that Judge Posner's environmental excise tax is second best to tougher regulation. The tax would enable government to compensate for environmental damage by cleaning it up, and in other ways. Tough regulation has a better chance of stopping the environmental damge happening.

The notion that drilling in our continental shelf will be a 'game-changer' is an illusion. That proposal is little more than appeasement to the idea that our affection for excess consumption of petroleum can continue.
In the long term, there is the matter of when or under what circumstances expanded offshore drilling will occur, and the separate issue of when or what will it take to foment a culture and technological shift to conservation and decreased use of petroleum. Drilling more oil offshore, so we can waste it sitting one person per car in twice-daily traffic jams is comparable to other destructive addictions. It has to end voluntarily, or it will end badly.
Only war or economic siege provide reasons compelling enough to tap reserves along our shorelines. Also, future technologies could enable reduce the environmental risks of drilling offshore, as well as transport.
On the tax, even a liberal like myself has to acknowledge the massive investment and risk of offshore exploration, so capitalism all but dictates that high risk entitles high returns. It's the current profit bubble that is offensive, but even so, lots of portfolios have benefited from the run-up. Thus, it's the consumers who choose to use gas and oil that probably need to be taxed for that use.

Since one could see this coming thirty years ago and nothing was done, nothing will be done now. The market will take care of some of it and geopolitics will take care the rest. Whatever the poiliticians do will surely be counter productive. We should be building nuclear plants as fast as possible, burning coal and reducing plastic use to near zero, suvs should be banned, the railroads should be rebuilt and public transport made usable. The other possibility is that at least the specualtive component will burst and a different bubble will start; how about fertilizer recycled from human waste.

If one thinks oil is going to become even scarcer in the generations ahead, and much more costly, it makes more sense to conserve domestic sources, and buy foreign sources as much as possible, and to put this extra money that you'd like to spend on domestic exploration and production into conservation or renewable technologies.

Also, do the cost benefit analyses take into account the possibility that oil left in the ground will end up being far more valuable to us in the future?

Perhaps there should also be a mechanism to distinguish oil use for industrial and public use vs. individual private use. Industrial use that benefits a lot of people has a more attractive cost-benefit ratio than private use i.e. for private vehicles, homes, etc.
More tax should be levied for the latter's use.

By industrial use, I mean oil‚Äôs use by business entities that produce goods for the local economy and generate jobs for the local communities. Many of these businesses are already hurting from the high price of oil, and increasing this cost further by taxation will only further erode their business viability. Given that the economy is already weak at this point, losing additional businesses to bankruptcy through higher taxation will only put more people out of work, and further deteriorate the economic environment.

"suvs should be banned" why so? What else should be banned? Maybe the travel trailer I use to take my family on vacation? I do not think a train will pull into the mountains. And if my suv should be banned, should we also ban the three kids I have? What about your family, maybe we should ban them from using computers (and you) since computers use energy and plastic as well?

Maybe what you are looking for Jim is a complete command and control society where I have no choices. My job will be determined by you and what I eat, when I sleep, when I love, when I live? How bout it? Sound appealing?

A remarkably uninformed post, alas, by Judge Posner. Like the enviro-Luddites who reflexively oppose any proposal to drill for more oil at any time, or anywhere, Posner seems frozen in the view that the oil and gas industry's exploration and production practices have not advanced technologically over the last 150 years.

"rogue" and Jim have the same ideas here. Legislate, command and control for the common good. A la the notion that it is government's responsibility to dictate how free people use resources. We need to perk up to this line of thinking! It is communism! Socialism! It's been continuously tried and failed. Sometimes I wonder if folks like "rogue" and "Jim" ever stop to wonder what made the US so successful in 230 years.

It is because of freedom and the free market! It is pure fallacy to believe that a benevolent government can step in and make better decisions than free individuals can. It's been tried again and again and again. It has failed always.

I concur completely with Judge Posner's comments about a carbon tax. It is too bad Rep. Dingell withdrew his bill. A carbon tax beginning at $10/ton of C02 and escalating to $100/ton (inflation adjusted) at $10/year increment would provide a huge incentive to conserve and switch to renewable energy sources without the market distortions of cap and trade. It would also balance the budget and pay down the national debt in about 20 years. By mid-century one could hope it brings in almost no revenue because carbon emissions are down so much.

The environmental risks of deep water drilling are shown by actual experience, not projection. the north Atlantic has some of the most severe weather on the planet, yet oil has been drilled there for years without serious incident. In the same way, Katrina showed us that even though a major hurricane can damage or destroy drilling platforms, the collateral environmental damage was minimal. Environmental concerns do not take into account the advances in technology that we have seen over the last 20 years.
BTW, Ryan, the impact of an excess profits tax is not conjecture; we tried it, we saw what happened when it was imposed, and when it was lifted.

nyexpat: The few decades of north sea experience says virtually nothing about tomorrow. When the decision was made (bought?) to ship AK oil by sea rather than down through Canada "studies" showed that a "significant spill" might happen once in 267 years.

Perhaps the bookies were right on their stats, but! a very significant spill happened in the first 30 years and gobs of oil remain on our beaches, and in our clam beds and estuaries today and many of our local people were put out of business. Every day is another spin of the roulette wheel in Alaska, the North Sea and everywhere else. Offhand I can't think of a decade that hasn't had a major spill somewhere in the world.

Should the pipeline have gone through Canada? Since we now import much of our oil by tanker it is our mid-western states that are short of oil, so much of the Alaska oil bypasses the oil filled ports of our W. Coast, goes to Panama, where it's often lightered into smaller tankers for the canal passage, then on to Louisiana where it goes into pipes heading north toward Ohio.

BTW in regard to excess profits the robed politicos of the SC just rebated Exxon $4.5 billion; shall we see if they invest it in good faith towards either new oil supplies or alternatives or whether they'll just continue to buy back their own stock?

A comment from Norway, where offshore oil and gas exploration now accounts for close to a quarter of GNP. Norway has for a long time had a windfall tax on profits form oil and gas exploration of 78%. From Beckers reasoning, this should lead to less exploration because oil companies profits are lower in case of the discovery of oil and/or natural gas. This might indeed be the case, but it depends on several factors omitted in the analysis. Three important ones are the the cost of searching, the probability of finding oil/natural gas, and the probable size of an oil/natural gas field. In mature areas, the probability of finding oil/natural gas might be low, and in those cases it might be necessary to let oil companies keep a large amount (or all) of the profits to keep up the exploration of new areas. The governemt should, however, make sure they have sufficient information about these factors. If the probability of finding oil&natural gas fields of considerable size is large enough, the government is giving away money if they don‚Äôt tax oil companies. The cost of reduced demand for search permits must be larger than the benefits society enjoy through higher government income.

The Norwegian government has made sure they had good information to base their decisions on, and used this to secure the oil companies a healthy returns to capital, but has also shared some risk by performing extensive geological surveys before oil companies were offered the opportunity to start exploration.

Some days ago the 20th round of blocs (given geographical areas) offered for exploration in the North Sea and the Barents Sea was announced. 79 new blocs was offered for exploration. The oil companies applied for more than 300. So it is not obvious that the large windfall tax on oil company profits has had a considerable effect on oil companies willingness to search for oil and natural gas in Norway.

Erland: Good and informative post. Here in Alaska we've been dealing with similar issues, although in the land of "free enterprise" the state receives about 20% from the oil that is on state land, and still the oillies howl like stuck pigs. (Sorry, the SC gift to Exxon just came down this week.)

Norway, Alaska and others can always reduce the royalty/taxes at some point in the future for those developing the marginal fields. To some extent Alaska's formula does some of this.

Those strongly favoring tapping ANWR shoud really consider what a gift it would be to BP/Phillips and Exxon if the typical formulas are used. ANWR is, of course, on Fed land.

Let's say there's well over a trillion bucks worth of oil there. The existing oil pipeline would provide most of the transportation and can handle about a million bbls of oil (above what is pumped today) per day. They'll have to build a 70 mile spur line and drill some wells; a couple billion or so to tap a trillion in oil. Just perhaps US taxpayers ought to get a goodly chunk of the return on the oil THEY OWN, as would a Texas rancher?